Retirement plan audit and contribution considerations

Executive summary: Significant new provisions available to qualified retirement plans

Qualified retirement plans have seen significant legislative changes over the last few years in the form of both new optional provisions, as well as required modifications. The volume of changes, along with staggered effective dates, the push back of amendment deadlines, lack of guidance from the IRS and changing workforce demands has confronted plan sponsors with an overwhelming number of operational decisions for their plans. In addition to staying in compliance with required modifications, plan sponsors are faced with considering which optional provisions may appeal to employees as part of their broader workforce and employee engagement strategy.

This article is the first of a 12-month series of articles where we will help plan sponsors and other affected stakeholders explore these evolving retirement plan provisions with practical applications for how they impact their businesses.

Compliance: Plan audit requirement

A question many employers raise each year is “Does my plan need an audit?” In the past, the answer generally has been that an audit is required when the number of plan participants as of the beginning of the plan year is 100 or more. A participant is an active employee who is eligible for the plan or a former employee who has a plan account. An eligible active employee does not have to have a plan account to be considered a participant. This caused some consternation amongst plan sponsors who had low participation rates resulting in a participant count of more than 100, but the number of participants with account balances being less than 100.

Beginning with 2023 plan years, the methodology to determine the audit requirement has changed. Rather than the threshold of 100 applying to the number of participants a plan has, the threshold is now based on the number of participants with an account balance as of the beginning of the plan year. For new plans that have no one with a balance as of the beginning of the plan year, the count is based on the end of year.

“We are always fielding a lot of questions with our middle market clients who have fast growing businesses on whether they need an employee benefit plan audit”, said Eric Carroll, Audit Partner.  “The practical advice I give to all our clients is once you’re approaching 100 participant account balances it’s time to start having a conversation with your accountant and planning for a future audit. First-year audits include a high level of effort because the auditor has to perform audit procedures to gain comfort over opening participant balances, which involves the plan sponsor providing the auditor historical records of the plan. Planning ahead for a future audit can make your first employee benefit plan audit a much smoother process.”

Even though the audit requirement is relatively straightforward, there are some nuances when plans are transitioning over or under the 100-account balance threshold or when there is a short plan year. Employers should work with their plan advisers (e.g., third party administrator, accountant) to confirm whether an audit is needed.

Compliance: Notice to employee of discretionary match contribution

Most 401(k) plan sponsors adopt a plan document that has been pre-approved by the IRS. This means the IRS reviewed the language of the document and has opined that it is designed in accordance with applicable sections of the Internal Revenue Code. Pre-approved plans must be restated every six years. The most recent version, which employers had to adopt by July 31, 2022, is referred to as the Cycle Three plan document. The Cycle Three IRS pre-approved plan documents include a newer rule on documenting discretionary matching contributions. In general, if an employer is using a fully discretionary match, then the employer must:

1. Provide the plan administrator (or trustee, if applicable), by the date the plan sponsor funds the discretionary matching contribution, written instructions describing the following (this notification can be informal and is not a new requirement):
   1. How the discretionary matching contribution will be allocated to eligible participants.
   2. The computation period(s) to which the discretionary matching contribution formula applies, e.g., each pay period or the entire plan year.
   3. If applicable, each business location or business classification subject to separate discretionary matching formulas.
2. Participants who receive the discretionary matching contribution must be notified of the same items described above within 60 days following the date the discretionary match is made to the plan. This notice is a new requirement.

Optional Provision: New Roth treatment available

Most everyone is familiar with the Roth concept. Contributions are deferred by an individual on an after-tax basis into a retirement plan (or an IRA) and, if certain requirements are met, at the time of distribution both the contributions and the earnings on those contributions are completely tax-free to the individual.

New provisions create an avenue for the Roth treatment to apply to more contributions. While these changes were included in the SECURE 2.0 legislation, in part, as a revenue raiser, it creates a significant planning opportunity for employees looking to increase their after-tax retirement benefits.

Effective as of Dec. 29, 2022, section 401(a) (e.g., profit sharing or 401(k)), section 403(b) and governmental section 457(b) plans may permit employees to elect to treat fully vested employer match and nonelective contributions as after-tax Roth contributions. The IRS provided guidance in Dec. 2023 about how this Roth treatment will be handled operationally.

• An employee must have an opportunity to elect (or change) Roth treatment at least once during each plan year. The election must be irrevocable and made prior to the allocation of the contribution to the employee’s account.
• The amount of the contribution is taxable income to the employee for the year in which the contribution is allocated to their account. For example, if the employee is receiving a match contribution for 2023, but it is deposited into her account in 2024, she is subject to taxation on the match contribution for the 2024 tax year.
• The designated employer Roth contribution is generally not considered wages for purposes of federal income tax withholding and is not reported on Form W-2. However, contributions may be considered wages for FICA purposes if made to an eligible governmental 457(b) plan.
• A Form 1099-R reporting the taxable amount is issued for the year the contribution is allocated to the employee’s plan account. In other words, the reporting is the same as is done for amounts rolled into a designated Roth account as an in-plan Roth rollover.

Similarly, employers sponsoring simplified employee pension (SEP) and SIMPLE-IRA plans can, but are not required to, offer employees the opportunity to designate a Roth IRA as the IRA to which plan contributions are made. The IRS’s Dec. guidance also addressed operational considerations for Roth treatment under these plans.

• Salary reduction contributions are taxable for the year in which the employee would have otherwise received the contributions as wages and are reportable on Form W-2 as wages for all withholding purposes and are reported using Code F or S, as applicable.
• Employer match or nonelective contributions are taxable in the year made to the Roth IRA and are reported on Form 1099-R in the same manner as a Roth IRA conversion.

Concluding remarks

Plan sponsors need to work closely with their plan advisors to understand the new requirements and optional plan provisions. Monitoring guidance as it is issued and knowing when implementation of required provisions is necessary will be crucial to ensure a plan is properly operated. Stay tuned for more information to come as we continue this discussion throughout our monthly series.